If a speculator expects that the Fed will intervene heavily by exchanging euros for U.S. dollars in order to affect the exchange rate, she would most likely ____ to capitalize on this intervention.

Question

Quizplus · Accepted Answer

If the speculator expects the Fed to intervene heavily in the foreign exchange market, she anticipates that the intervention will lead to a depreciation of the euro and an appreciation of the U.S. dollar. Therefore, she would purchase euro put options, which give her the right but not the obligation to sell euros at a predetermined price. This way, if the euro does depreciate as she expects, she can sell her euros at a higher price than the market rate and earn a profit. Alternatively, she could sell euro futures contracts or purchase U.S. dollar call options, but purchasing euro put options is the most direct and effective way of capitalizing on the expected intervention.

If a Speculator Expects That the Fed Will Intervene Heavily